Iluka Resources ((ILU)) will review the corporate and capital structure of its two principal operations – mineral sands and the Mining Area C (MAC) royalty from Western Australia.

The review is welcomed by the broking fraternity as UBS notes, in the case of the latter, many have questioned whether the market is correctly valuing the royalty. This is not the first time Iluka Resources has looked at ways to monetise the royalty, although previous attempts have encountered tax obstacles.

Meanwhile, the company remains constructive on the outlook for zircon, expecting a market deficit because of declining supply, although conditions continue to be affected by global economic uncertainties.

Demand in the key markets of China and Europe is soft and customers have been reducing zircon inventory across the supply chain. Still, amid declining supply from key producers, including depletion of the Jacinth-Ambrosia mine, a deficit should emerge, in the company's view.

Yet, while zircon substitution has not been evident in recent years, increased thrifting has been a feature of the market. The use of thinner tiles and ultrafine grinding has had an impact. Customer inventory of zircon may have been reduced but remains above historical levels, Citi points out.

Macquarie suspects the near term outlook for zircon is subdued and reduces sales forecast for the December quarter, downgrading the stock to Neutral from Outperform and assessing that a forecast step-up in zircon sales without further impact on prices is unlikely.

Iluka has recently announced loyalty rewards and adjusted its product mix, which has started to affect the company's realised zircon price. Also, a more conservative staged development at Sierra Rutile is expected to limit output.

The company is reviewing the development plan for Sierra Rutile's Sembehun, which has effectively been brought back to the scoping study stage, and Macquarie suspects Iluka will use the development to extend mine life rather than grow production.

Operations at Sierra Rutile continue to be below Morgan Stanley's expectations, although expansion projects at Lanti and Gangama are now complete and should drive zircon production higher in 2020.

Citi amends its forecasts for Sierra Rutile, lowering nameplate production over 2022-23 ahead of the assumed transition to Sembehun in 2024 and expecting a drop in production as the company will only operate one mine ahead of the eventual start-up.

Citi believes Sierra Rutile has not lived up to expectations and logistics remain the largest challenge. The company has conceded it significantly underestimated the difficulties in operating in Sierra Leone.

Titanium Dioxide

Iluka also expects an upturn in pigment demand for feedstocks by mid 2020. Titanium pigment accounts for a more than 80% of feedstocks demand.

At Cataby, Western Australia, where commissioning began in January, ramp-up has been affected by the use of refurbished equipment as well as labour availability. The near-term challenge will be to get mining rates to target levels by March in order to ensure sufficient feed for the synthetic rutile kiln 2.

In November, the company will undertake rectification work. The re-start of the company's synthetic rutile kiln 1 remains an option, Citi notes, although ilmenite feed would need to come from Cataby or third parties.

Another issue at Cataby is water. Macquarie notes a significant proportion of the reserve is located below the water table and rainfall can also affect the operation. The broker expects Iluka will mine well ahead of processing rates during the summer and build a stockpile ahead of the next winter.

Mining Area C

Morgan Stanley suggests a review of the MAC royalty is a strong positive development. The company has appointed a third party to review the structure of the royalty, with a de-merger or dividend stream being considered.

Macquarie does not doubt the review is a positive catalyst but considers it outweighed by the softness in near-term demand for the company's products and the risks to volume and price.

The potential spin-off of the royalty is likely to force a review of the MAC valuation parameters, and Ord Minnett envisages a number of possible benefits such as a favourable change to the dividend policy, should the tax consequences be overcome.

The company believes it can de-merge the royalty in a tax efficient manner. For the Australian Taxation Office to grant rollover relief from capital gains tax under a de-merger of the royalty to a new company commercial efficacy needs to be proven, rather than just the ability to distribute earnings, Citi points out.

Iluka intends to advise the market of the outcome of the review by February. Citi assumes $100m in debt would be transferred, allowing Iluka Resources to go forward with no net debt. While the valuation metrics for the de-merged mineral sands scenario are low, the broker notes they are in line with its forecasts for both South32 ((S32)) and OZ Minerals ((OZL)).

FNArena's database has one Buy (Morgan Stanley) and five Hold ratings. The consensus target is $9.19, suggesting 4.5% upside to the last share price. Targets range from $8.10 (UBS) to $11.15 (Morgan Stanley).

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